The 1990s witnessed a fervor for mutual funds that reverberated across the nation, as noted by Kumar. A subsequent news report revealed the astonishing debut of ‘Master Gain 92,’ attracting a staggering 6.5 million investors, setting an equity fund record. Kumar recalls that such excitement surrounding mutual funds has not been seen since. This marked the inception of India’s mutual fund (MF) industry, which has since burgeoned into a massive industry with assets under management (AUM) amounting to ₹46 trillion.
Speaking at a conference of chartered financial analysts, Kumar attributed the remarkable demand for the Master Gain 92 fund to the logistical challenges faced by small investors when dealing with stockbrokers for share transactions. For these investors, the easiest route to market participation was through mutual fund units, providing them with indirect exposure to equities. During this period, the stock market was in the throes of the Harshad Mehta bull run, enticing even ordinary individuals to join the stock market frenzy.
However, the landscape transformed over time as the Securities and Exchange Board of India (SEBI), the market regulator, implemented measures to streamline and democratize mutual funds, accelerated by technological advancements.
We reached out to industry veterans to trace the evolution of the MF ecosystem since the 1990s. Back then, MF distributors were known as Independent Financial Advisers (IFAs) and earned substantial commissions in various forms, including annual charges, entry load, exit load, and initial issue expenses. The latter was levied during a fund’s launch, analogous to an initial public offering today. Asset management companies (AMCs) could impose an initial issue expense of up to 6%, covering their costs and commissions. Both entry and exit load commissions could soar as high as 7%, with distributors benefiting from a portion of these commissions. An entry load applied when an investor purchased a fund, while an exit load was levied when an investor sold it.
Gradually, SEBI embarked on a journey to dismantle this commission structure. The initial issue expense was eliminated in 2008, followed by the abolition of entry loads in 2009, which could no longer be used to pay distributor commissions. Exit load amounts had to be reinvested in the fund’s net asset value (NAV).
In 2012, SEBI introduced an incentive called beyond-15 (B15) to expand MF penetration. This program offered higher commissions for selling MFs in cities beyond the top 15. Simultaneously, SEBI introduced transaction fees for MFs, charging ₹150 for new investors and ₹100 for existing investors for each transaction exceeding a specified threshold.
In 2013, SEBI introduced direct plans, enabling investors to purchase MF units directly from AMCs, bypassing intermediaries and commissions. The same year, registered investment advisory (RIA) services were permitted, regulated by SEBI, allowing for fees but prohibiting commissions on regular mutual fund plans.
Mutual Fund Distributors (MFDs), who were present from the inception of MFs in India, continued to evolve. These distributors, individuals or corporations registered with the Association of Mutual Funds in India (AMFI), could earn commissions on MF sales. As of June 2023, there were 1.4 lakh registered distributors, with 6,600 being corporate distributors and the rest individuals. Notably, the distribution business was heavily concentrated in the hands of top players.
Distribution channels were categorized into three groups: national distributors (NDs), MFDs (or independent financial advisers), and banks. In fiscal year 2022, individual MFDs held a 17% share of the total AUM, while national distributors and banks commanded 49% and 34%, respectively.
Many MFDs also functioned as wealth managers, as Indians were unaccustomed to paying fixed fees for advisory services.
RIAs emerged as an alternative for investors concerned about portfolio churning or cross-selling. RIAs could offer fixed-fee advisory services, reducing the incentive to promote high-commission products. However, stringent regulations and compliance norms deterred many from pursuing RIA licenses. There were approximately 1,300 RIAs in the country, primarily concentrated in the top 5 cities, leaving a majority of the population without access to RIA services.
India lagged in adopting a fee-based model for wealth management, with a substantial reliance on commissions. In 2018, only 14% of income for Indian wealth managers was fee-based, compared to 45% globally. Indian wealth managers predominantly depended on commissions, constituting 58% of their total income.
The proliferation of fintech apps, catalyzed by the introduction of direct plans in 2013, provided a modern and user-friendly means of investing in mutual funds. These apps integrated with registrar and transfer agents and exchange-run platforms, offering commission-free mutual funds within minutes, contingent on proper documentation. However, fintech apps aimed to generate revenue by engaging customers with other financial products, raising concerns about selling unsuitable products to retail investors.
Suresh Sadagopan, an RIA and founder of Ladder7 Financial Advisor, emphasized the need for MFDs, fee-based RIAs, and direct plan apps to expand their services to cater to India’s diverse needs. He lamented the onerous compliance requirements that had made the RIA business unsustainable.